Fixed income: Opportunities and risks

With bonds once again providing balanced portfolios with diversification and protection, investors are considering their fixed-income holdings.

“The correlation between risk assets and fixed-income securities has normalized,” said Adam Ditkofsky, vice-president and portfolio manager, core and core plus, with CIBC Asset Management, in a recent interview.

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This development, combined with higher interest rates, central bank easing and stabilizing inflation, means “government bonds, corporate bonds and innovative income-oriented solutions all offer attractive opportunities,” he said.

Ditkofsky expects the Bank of Canada will continue its rate-cutting cycle into 2025 as inflation stabilizes within the central bank’s target range of 1% to 3%, and as the economy shows some cracks.

“Businesses’ spending remains low, productivity is weak,” Ditkofsky said. “Consumers remain sensitive to interest rates, especially those who need to refinance their mortgages in the coming months.”

Also, the unemployment rate continues to climb, he noted, and was more than 6.5% at the end of September.

“So far, the economy has been resilient, but if we see growth slow faster than anticipated, the [central] bank will likely need to cut more, and if inflation starts to reaccelerate, we may need to see the [central] bank pause,” he said.

The Bank of Canada’s next rate decision comes Wednesday.

Rate cut expectations get priced in to the market, Ditkofsky noted, “so we aren’t expecting yields to materially move, particularly for 10-year and 30-year bonds.” 

With a soft-landing scenario so far unfolding as monetary policy eases, credit has been “extremely strong this year,” Ditkofsky said.

“Both investment grade and high yield have outperformed the broad bond market over the past 12 months, and investors continue to benefit from higher yields and tightening spreads,” he said.

Investment-grade bonds yield between 4% to 5%, while high yield has been stable at about 7%, he noted.

“We continue to expect corporate bonds will continue to outperform, especially as demand remains extremely robust and provides investors with attractive yields,” he said.

He also noted that the relationship between government bond yields and corporate bond spreads has normalized.

“This should provide more stability for corporate bonds, as they benefit from lower yields in risk-off periods and tighter spreads in risk-on periods, both partially offsetting each other,” Ditkofsky said. “This means more stability, less volatility — both being favourable characteristics for the fixed-income investment market.”

Ditkofsky also noted the move to higher yields in recent years has driven product innovation within fixed income.

“One area where we’ve seen innovation relates to products that are absolute return–oriented, as opposed to benchmark-oriented,” he said, citing target-date maturity funds.

Other opportunities include using derivatives in portfolios, Ditkofsky said, which allows investors to manage interest-rate risk and take advantage of specific inefficiencies in the bond market.

In terms of risks heading into 2025, Ditkofsky cited the potential for inflation to increase as well as the upcoming U.S. election, “which can cause a lot of uncertainties in the market depending on the results.”

He also cited global military tensions, especially in the Middle East, “which could be very supportive for bond yields but … very negative for risk assets,” he said.

“Ultimately, there’s a lot of uncertainties in the market right now, which reflects why it’s important for risks to be appropriately balanced and managed within investment portfolios,” Ditkofsky said.

This article is part of the Advisor To Go program, powered by CIBC Asset Management. It was written without input from the sponsor.